Question 1

Calculate the payback period for a project with the following cash flows, if the company's discount rate is 12%. Initial outlay = $450
Cash flows: Year 1 = $325
Year 2 = $65
Year 3 = $100

Accepted Answer

The payback period is the time it takes for the cumulative cash flows to equal the initial investment. After Year 1, $325 is recovered. After Year 2, $390 is recovered ($325 + $65). The remaining $60 is recovered in Year 3. Since $100 is received in Year 3, it takes 0.6 of a year to recover the remaining $60. Thus, the payback period is 2 + 0.6 = 2.6 years.

Question 2

Net present value=

Accepted Answer

Net present value is the present value of future cash flows minus the initial cash outlay. It is used to determine the profitability of an investment by comparing the present value of expected cash inflows to the present value of expected cash outflows.

Question 3

Your company is considering a project with the following cash flows: Initial outlay = $1748.80
Cash flows in years 1-6 = $500
Calculate the IRR on the project.

Accepted Answer

Using the formula for calculating IRR, we get:
1748.80 = (500/1+r) + (500/1+r)^2 + (500/1+r)^3 + (500/1+r)^4 + (500/1+r)^5 + (500/1+r)^6
Simplifying and solving for r, we get r=18%. Therefore, the IRR on the project is 18%. This is the best choice as it is the only option provided that is a possible answer for the IRR calculation.

Question 4

Two projects are under consideration by the same company at the same time.Project Alpha has a NPV of $20 million and an estimated useful life of 10 years.Project Beta has a NPV of $12 million and also an estimated useful life of 10 years.What should the company's decision be
a)if the projects involve unrelated expansion decisions or
b)if the projects are mutually exclusive because they would have to occupy the same space?

Accepted Answer

The answer of Two projects are under consideration by the...

Question 5

Project Black Swan requires an initial investment of $115,000.It has positive cash flows of $140,000 for each of the next two years.Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $170,000.If the company 's required rate of return is 12%, the project should be

Accepted Answer

Using the NPV method, we can calculate the present value of the cash flows using a discount rate of 12%. NPV = -$115,000 + ($140,000 / 1.12) + ($140,000 / 1.12^2) + ($170,000 / 1.12^3) = $12,201.50. Since the NPV is positive, the project should be accepted.

Question 6

Given the following annual net cash flows, determine the IRR to the nearest whole percent of a project with an initial outlay of $1800. Year Net Cash Flow

Accepted Answer

Using trial and error or a financial calculator, we can calculate the IRR to be approximately 14%. This means that the project's rate of return is 14%, which is higher than the required rate of return, making it a profitable investment.

Question 7

Equipment should be replaced whenever replacement results in a positive NPV.

Accepted Answer

NPV is the net present value, which takes into account the initial cost of the equipment, its expected useful life, and the estimated future cash flows it will generate. If the NPV is positive, it means that the benefits of replacing the equipment outweigh the costs, and it is therefore financially sensible to replace it.

Question 8

If a project has a profitability index greater than 1,

Accepted Answer

If a project has a profitability index greater than 1, it means that the present value of future cash flows is greater than the amount invested, which also implies that the NPV will be positive. Additionally, since the profitability index is calculated by dividing the PV of future cash flows by the initial investment, a profitability index greater than 1 indicates that the PV of future cash flows is more than the initial investment, and so the IRR will also be higher than the required rate of return. Therefore, all three statements are true, and the correct answer is D.

Question 9

Corp Suite is considering two expansion options, but does not have enough capital to undertake both.Project W requires an investment of $100,000 and has an NPV of $10,000.Project D requires an investment of $80,000 and has an NPV of $8200.If Corp Suite uses the profitability index to decide, it would

Accepted Answer

The profitability index (PI) is calculated as the ratio of the present value of future cash flows (or NPV + initial investment) over the initial investment. For Project W, PI = (110,000 / 100,000) = 1.1. For Project D, PI = (88,200 / 80,000) = 1.1025. Project D has a higher PI, making it the preferred choice.

Question 10

Project Black Swan requires an initial investment of $115,000.It has positive cash flows of $140,000 for each of the next two years.Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $170 000.

Accepted Answer

Since the project has positive cash flows for the first two years, the IRR cannot be negative. However, the cash flow in the third year creates a potential for multiple IRRs. Therefore, the project might have more than one IRR, but it can have only one Modified Internal Rate of Return (MIRR), which is a more reliable measure for project evaluation in such cases.

Question 11

Net present value is suitable for comparing projects with unequal lives.

Accepted Answer

Net present value (NPV) does not inherently account for differences in project lifespans, which can lead to misleading comparisons when evaluating projects with unequal lives. Methods like equivalent annual annuity (EAA) are better suited for such comparisons.

Question 12

Manufacture Hawk has two options for installing legally required safety equipment.Option Ex has an initial cost of $25,000 and annual operating costs over three years of $5000, $5250, $5600.Option WYE has an initial cost of $40,000 and annual operating costs of $4000, $4200, $4450, $4750 and $5100.Whether Manufacture Hawk chooses Ex or Wye, the equipment is always needed and must be replaced at the end of its useful life.Which choice is least expensive over the long run? Use a discount rate of 9%.

Accepted Answer

The answer of Manufacture Hawk has two options for installing...

Question 13

A project has an initial outlay of $4000.It has a single payoff at the end of year 4 of $6996.46.What is the IRR for the project (round to the nearest percent)?

Accepted Answer

The answer of A project has an initial outlay of...

Question 14

Rockwell Smoothie is considering a project with the following cash flows
Initial outlay = $13,000
Cash flows: Year 1 = $5000
Year 2 = $3000
Year 3 = $9000
If the appropriate discount rate is 15%, calculate the NPV of this project.

Accepted Answer

The answer of Rockwell Smoothie is considering a project with...

Question 15

What is the NPV of a $45 000 project that is expected to have an after-tax cash flow of $14,000 for the first two years, $10 000 for the next two years, and $8000 for the fifth year? Use a discount rate of 8%.Would you accept or reject the investment?

Accepted Answer

The answer of What is the NPV of a $45...

Question 16

Project Black Swan requires an initial investment of $115,000.It has positive cash flows of $140,000 for each of the next two years.Because of major demolition and environmental clean-up costs, cash flow for the third and final years of the project is $170,000.

Accepted Answer

Since the project has both positive and negative cash flows, it is possible for it to have more than one IRR. In this case, the project has positive cash flows for the first two years, followed by a larger positive cash flow in the final year, which could result in multiple potential rates of return. Therefore, it is possible that this project might have more than one IRR.

Question 17

What is the NPV of a $45,000 project that is expected to have an after-tax cash flow of $14,000 for the first two years, $10 000 for the next two years, and $8000 for the fifth year? Use a 10% discount rate.Would you accept the project?

Accepted Answer

The answer of What is the NPV of a $45,000...

Question 18

Mutually exclusive projects may be ranked differently when higher or lower discount rates are used.

Accepted Answer

Mutually exclusive projects compete with each other and only one project can be chosen. Discount rate affects the present value of future cash flows, and thus affects the ranking of the projects. When a higher discount rate is used, projects with earlier cash flows may be favored and ranked higher, while projects with later cash flows may be ranked lower. When a lower discount rate is used, the opposite may occur. Therefore, the ranking of mutually exclusive projects can be influenced by the discount rate used for evaluation.

Question 19

The higher the discount rate, the greater the importance of the early cash flows.

Accepted Answer

When the discount rate is higher, the value of future cash flows decreases. Therefore, early cash flows become relatively more important and have a greater impact on the present value of an investment.

Question 20

The required rate of return represents the cost of capital for a project.

Accepted Answer

The required rate of return is the minimum return that an investor demands from an investment to compensate for the risk and opportunity cost of investing in that project. It is also known as cost of capital, as it represents the cost of obtaining funds to finance the project.

Quiz 11: Investment Decision Criteria

Calculate the payback period for a project with the following cash flows, if the company's discount rate is 12%. Initial outlay = $450 Cash flows: Year 1 = $325 Year 2 = $65 Year 3 = $100